In this blog, Erik Pickett discusses a cognitive bias known as the outcome bias.
Je ne regrette rien
In early September, I went to France for a friend’s wedding and a late summer vacation. I rented a car and opted for full insurance with the minimum deductible. In deciding the level of insurance, I weighed up the cost of the premium against the possible cost of an accident and my perceived likelihood of having a fender-bender on the small twisty roads in the South of France[1].
I had a great time on my vacation and in the end, I returned the car without a scratch. However, when talking to a friend about this recently, they suggested that I must be annoyed given that I’d bought insurance that I hadn’t needed. I can certainly understand this viewpoint, but it really seems strange to be annoyed that I hadn’t had an accident. I’m still confident that I’d made a reasonable decision at the time and one extra data point should not invalidate that decision. So, what is causing these competing emotive and rational responses?
The outcome bias
It turns out this is an example of a cognitive bias known as the outcome bias, whereby the outcome of an event shapes our view of previous decisions relating to the event.
In short, a bad outcome is likely to make us more likely to think we made a bad decision, and a good outcome is more likely to make us think we made a good decision.
The literature is full of examples of the outcome bias. Medical decisions, monetary gambles, pilots flying in poor weather conditions and even the morality of a scientist falsifying their results. In all these cases the protagonist is judged more harshly in the event of a poor outcome, with poor decisions being overlooked after a fortunate outcome.
Research also shows that the performance of sports players is judged by the ultimate result of the game or play. If Swedish soccer player Zlatan Ibrahimovic places a penalty kick straight into the middle of the goal, he is deemed a genius if he scores with the goalkeeper diving to the side, but foolish if the goalkeeper stands his ground and catches the ball![2]
The outcome bias embodies the sentiment that ‘the end justifies the means’.
One step beyond
David Robson, in his excellent book The Intelligence Trap, goes one step further than judging past decisions. He asserts that the more near misses someone has, the more they underestimate the future risk. Among others, he gives the example of the NASA space shuttle Challenger crash in 1986. The disaster was caused by the deterioration of a faulty seal. Upon investigation it turned out that the seal had deteriorated similarly on many previous missions but had not resulted in an accident. It had happened so often that it was seen as a nuisance and overlooked as a warning sign. It could be that this repeated good fortune had caused NASA to overlook the risk posed by the faulty seal, with the crash being the ultimate price. During the investigation Richard Feynman made his now famous quote:
“When playing Russian roulette, the fact that your first shot got off safely is little comfort for the next.”
Game shows have a lot to answer for
A perpetuation of this bias of this can be seen in the TV game show “Deal or no deal”. I won’t go into detail about the format, but essentially it comes down to a contestant being offered an amount of money to stop playing the game – if they continue to play, the outcome is uncertain with both chances of winning more and chances of winning less money than the deal they were offered.
There could be many reasons to accept a deal in this game. The contestant could make a call on their expected return if they continue to play. Or, the amount offered could be so life-changing that they do not want to risk losing it for a chance of a bigger win. Regardless of the reason, the contestant must base their decision on the information they have at the time.
However, whether it’s Howie Mandel or Noel Edmonds presenting, the end of the show always includes playing out the game to see what would have happened. In the event the contestant accepted a lower deal than ‘what they would have won’, the contestant is chastised by both the host and themselves for making a bad decision. But just because the outcome is bad (winning less money than was possible), it does not mean the decision was bad! At the time the decision was made, the risk was real. Events could easily have turned out differently, so the decision should not be judged by the ultimate outcome.
The longevity effect
The outcome bias is particularly damaging to people’s view of insurance contracts. If we take out insurance and we don’t need to claim, the bias leads us to regret the money spent on the premium. But this is a fallacy. We are really paying not to worry about the particular path the world takes along random events – and where some of these events could be ruinous. We pay the premium for certain outcomes.
This is especially pertinent for pension plans considering longevity insurance. Longevity insurance, whether in the form of a buy-out or a longevity swap, seeks to replace an uncertain set of cashflows (dependent on the ultimate lifespan of the plan’s participants) with a fixed set of cashflows. If a pension plan decides to take out longevity insurance, the decision should not be judged by whether plan participants actually end up living longer or shorter lives than predicted. The decision should be judged on the increased security gained from the certain cashflows together with the cost of the premium.
What do you think?
Whether it’s car insurance, a longevity swap or Zlatan’s positioning of a penalty kick, it’s difficult not to regret perceived missed opportunities. But next time you find yourself ruing a previous decision, maybe spare a thought for your past self (or Zlatan) who was just doing their best with the information they had at the time.
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[1] I did stop short of pulling up historical data to estimate the probability of a claim and calculating my expectation of loss – it was a vacation after all!
[2] North American readers, please forgive the European example, old habits die hard. A penalty kick in soccer represents a moment that can completely alter the course of a game; it involves one free shot on goal with only the goalkeeper to beat. Both players involved sometimes decide how they will play the penalty long before it is even awarded; their decision making is often compared to a game of rock-paper-scissors.
Zlatan Ibrahimovic is Sweden’s top ever goal scorer, but often divides opinion about whether he is a genius or over-confident and unnecessarily risky.